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How economic market structures influence transport and logistics markets

Having explored the different market structures, you should now realise how difficult it is to apply any of them to real-world markets such as transport and logistics. Models provide us with a more simplistic framework than real life, in which to analyse why certain changes in markets and policies cause different effects, which is useful even if it doesn’t describe all the complexities present in the real world.

Governments have a great deal of influence on ensuring markets operate as efficiently and fairly as possible, although some schools of thought believe the market is the best at allocating resource. Businesses and firms are particularly innovative in macroeconomic environments that bend regulations and chase profitability. It is the job of governments to protect consumers, the environment and human rights, which markets are not good at recognising.

It’s often difficult to distinguish between a monopoly and an oligopoly or duopoly, as all may exhibit behaviour that reflects monopoly power. Monopolies and oligopolies do not necessarily aim for the traditional assumption of profit maximisation. Monopolies are not always ‘bad’; they may be desirable in some cases but may need strong regulation. Control of railways by governments or private companies is often contested around the world: some think private businesses are better at allocating resources, others think governments should fund them because they are high-cost and benefit all.

Finally, monopolies don’t have to be big; they might exist locally or based on time (a company having been in the market the longest). There are examples of this within transport and logistics, such as railway and bus services that exhibit this sort of monopolistic power.

Contestable markets

Transport and logistics markets don’t fit neatly into the types we have discussed so far. One theory that helps to explain why this is and how they do function, is the theory of contestable markets.

A degree of contestability of the market may influence firms’ behaviour too, as pointed out by the theory developed by Baumol et al. (1982). The perfectly contestable market in its pure form (not common in reality) is a useful benchmark to explain firms’ behaviours that do not fit some of the market structure theory we’ve discovered so far. It’s also useful for explaining the behaviour of markets in transport.

A contestable market is basically a monopoly that has low barriers to entry. There are several key characteristics of transport and logistics markets that define them as contestable.

Contestable markets typically have high sunk costs (costs that have already been paid), so firms feel threatened by new entrants. Transport and logistics businesses often have high investment and sunk costs. This encourages firms to erect artificial barriers, such as deliberately limiting profits, to discourage new entrants.

Another tactic to stop competition is to create over-capacity within the market, to drive prices down and keep out competition. Within transport and logistics, deep-sea container shipping has been accused of this tactic.

Aggressive marketing and branding strategies may be used to keep competition out of the market.

Firms find ways to reduce costs and increase efficiency to gain competitive advantage over others. An example of this is again with maritime container shipping, where liners are continually building bigger ships to carry more containers.

Another characteristic is hit and run tactics, where a firm enters an industry, takes any profit they can and gets out quickly. This is possible in contestable markets because of the freedom of entry and exit.

Finally, cream-skimming involves identifying parts of the market that are high in value-added services and exploiting those markets. An example is the delivery/fitting costs for a washing machine: you might want it fitted in your house, so they charge a high price for the service as it’s no good unless it is fitted.

The limitations of market models

Remember, market structure models can be used as a comparison and to set general rules or trends, but not necessarily to reflect all the complexities of reality. The key thing to take away from what we’ve covered this week is that when looking at real-world examples, you should focus on the behaviour of the firm in relation to what the model predicts would happen. This gives us the basis for analysis and evaluation of a real-world situation.

Regulation, or the threat of regulation, may well affect the way a firm and a market behaves. The way that governments deal with firms may be based on a general assumption that more competition is better than less.

Finally, these models are based on certain assumptions. In the real-world, some of these assumptions may not be valid, but this allows us to draw comparisons and contrasts, and have an understanding of how the market is operating economically.


References

Baumol, W. J., Panzar, J. C., and Willig, R. D. (1982). Contestable markets and the theory of industry structure. Harcourt College Pub.

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This article is from the free online course:

What is Economics in Global Logistics?

Coventry University